Last week, House and Senate offices received a letter signed by Citizens for Tax Justice, the Coalition on Human Needs, and OMB Watch, asking Congress to reverse a Treasury notice that essentially told banks that they could ignore an explicit provision in the revenue code intended to prevent abusive tax shelters. The notice, dubbed the "Wells Fargo ruling," after its largest beneficiary to date, will cost the federal government $140 billion according to one widely-cited analysis.

As the letter was being sent, legislation was introduced in both the House and Senate to reverse the Treasury notice. (In the House, Congressman Lloyd Doggett (D-TX) introduced H.R. 7300. In the Senate, Vermont's Bernie Sanders introduced S. 3692.)

As the letter sent to the Hill explains, IRS Notice 2008-83 essentially repeals, for banks only, Section 382 of the tax code, which bars companies from using the losses of companies they acquire to reduce their own tax liability. Section 382 was enacted by Congress in 1986 to stop companies from sheltering their income by purchasing shell companies with losses on their books. Before that time, many mergers took place not because they made economic sense but merely because they offered a tax shelter. Ever since Section 382 was enacted to end these abuses, corporate lobbyists have been promoting its repeal.

Now it seems those lobbyists have achieved their goal without using the same long and difficult legislative process that lawmakers and advocates face when they want to enact, say, a $3 billion increase in the child tax credit for low-income families. Instead, bank lobbyists achieved their $140 billion goal through an agency action that contradicts the explicit intent of a statute enacted by Congress.

Another alarming aspect of the Wells Fargo ruling is its impact on states. As CTJ's recent report explains, because most state corporate taxes are linked to the federal corporate tax, a cut in the federal corporate tax leads to a reduction in state revenues as well. It has been reported that the total loss in state revenue for California alone will be $2 billion, and $300 million of that will be lost this year.

Many lawmakers and analysts are rightly concerned about the economic effects of any change in tax law enacted by Congress. But that can be no excuse to leave unchallenged a $140 billion tax subsidy for bank mergers created in direct contradiction to a law enacted by Congress. The House and Senate will likely meet in December to consider a bailout for the automotive industry and other legislation to boost the economy. During that time, they should approve legislation to reverse the Wells Fargo ruling.

As the vast majority of state governments stare down budget shortfalls, new ideas about how to responsibly and fairly fill those gaps should receive an enthusiastic welcome. A new report from Good Jobs First, entitled Skimming the Sales Tax, does exactly that by revealing that states are currently giving away over $1 billion through "vendor discounts" or "dealer collection allowances" that reduce sales taxes.

Vendor discounts allow retailers to legally keep a portion of the sales tax revenue they collect as compensation for the costs involved in collecting and remitting the tax. Twenty six states currently provide retailers with such compensation, amounting to a total of over $1 billion in annual revenue losses for those states.

The policy prescription in many states is fairly clear. While there may be room for debate over whether any compensation is warranted, what is not in question is that there should be a sensible limit on the maximum amount that any one business can receive via this practice. As author Philip Mattera points out, "the main expenses that retailers incur with regard to sales taxes, especially software programs to track them, are fixed costs that do not rise in tandem with growth in receipts."

Those states without such a limitation in many cases forfeit quite substantial amounts of revenue through vendor discounts. Illinois, for example, loses over $126 million annually due to the practice. Texas, Pennsylvania, and Colorado each lose in the neighborhood of $70 - $90 million per year. Thirteen of the twenty six states offering vendor discounts do not cap the amount any individual retailer can claim. In addition, five states that do impose limits on maximum compensation have set those limits at seemingly excessive levels, ranging from $10,000 to $240,000 per retailer.

For state-by-state details on existing vendor compensation practices, as well as other ways in which retailers are being subsidized through the sales tax, see the report here.

Most of the tax proposals recently on state ballots would have, if approved, made state tax systems less progressive, but a new proposed ballot question in Utah would do the opposite. There, an initiative is being promoted by a group called the Rings True Coalition who are rightly aghast at the inherent unfairness of their state's single rate tax structure. Their proposal would replace that single rate tax structure with a six-bracket progressive income tax. It's not news to us that a flat rate income tax is not fair to low income folks. Doug MacDonald, a former chief economist for the Utah State Tax Commission brings this point home when he offered examples to the Deseret News of several low-income folks who actually saw their tax bill increase when the flat tax went into effect. He says, "The effect of the flat tax is that it's unfair, random and has unintended consequences." As our most recent policy brief explains, the progressive income tax is an essential element of a fair and sustainable tax system. We'll keep our eyes on the Beehive State for what could become the next big tax policy fight.

The state of Michigan continues to fall on hard times economically. The Center on Budget and Policy Priorities estimates that the state's budget gap for FY 2009 is $472 million (nearly 5 percent of the state's general revenue fund), the automobile industry is on the verge of bankruptcy and the state's infrastructure isn't adequate to support the needs of Michigan residents. Last week the infrastructure issue was addressed head-on by the release of the Transportation Funding Task Force's report.

The blunt report sums up Michigan's infrastructure problems this way: "Michigan is approaching a crisis of infrastructure funding caused by steady erosion of purchasing power, continued inflation in materials costs, and a decline in fuel-tax revenues due to spikes in gas prices, reduced travel and a slow economy. The decline in revenues, and a corresponding increase in demand for travel alternatives, has exposed the inherent structural problems with the current means of transportation finance."

The Task Force outlined a menu of funding alternatives available including: increasing registration fees, adjusting the motor fuel tax, increasing the sales tax, and increasing the aviation fuel tax. Look here for the complete list. Anti-tax lawmakers will naturally balk at some of these options, but many others will be prodded by the budget crisis to consider options that had previously seemed politically difficult. They should delve deep into this report and focus on investing in Michigan's infrastructure. Task Force members rightly caution, "The one choice we cannot afford is to do nothing."

In the wake of revelations that Wells Fargo Bank stands to reap $20 billion in federal tax cuts from a probably-illegal tax giveaway imposed on us by departing leaders in the Bush Treasury Department, the most obvious question was which other large corporation would be next in line to cash in on this particular tax break. The answer: PNC, which just bought Ohio-based National City Bank.

As with the Wells Fargo case, the generosity of the tax break leaves one dumbfounded. As the Cleveland Plain Dealer asks:

How can PNC pay $5.6 billion for National City and get back more than $5 billion in tax breaks?

It's a rhetorical question, of course: the Plain-D guys know that this tax break exists because of clever back-room maneuvering by Bush Administration Treasury officials. The short explanation: 20 years ago, Congress passed a law (as part of the justly-celebrated Tax Reform Act of 1986) that prohibited banks from buying loss-ridden banks as a tax dodge. While lobbyists pushed hard for Congress to undo this change for, well, the next 20 years, they were unsuccessful-- until the Treasury Department decided to change the law themselves by issuing a notice saying that they've changed their interpretation of the law. Oversimplying a bit, Treasury officials have taken a law that says "this tax scam is not allowed" and basically crossed out the "not".

Plenty of people are now paying attention to this anti-democratic outrage, not least among which are the members of Congress who view the creation of absurd tax breaks as their domain alone. (They're right, for better or for worse.) But the real question remains: what can be done about this?

An incoming Obama Administration can (and should, if all else fails) simply rewrite the administrative regulations. Again resorting to a gross oversimplification, this means un-crossing-out the "not" mentioned above.

Alternatively, tax writers in Congress (who are peeved that Treasury usurped their authority on this one) could pass a law preventing banks from using this made-up loophole going forward.
A stickier issue is whether anything can be done to take away the tax breaks already claimed by Wells Fargo and PNC. If their purchases of unprofitable banks were driven by the tax break, it may seem unfair to take the tax breaks away retrospectively, but there's enough unfairness to go around: Wells Fargo got a tax break that Citigroup didn't, entirely because Wells Fargo tried to buy Wachovia right after Treasury's announcement-- and Citigroup had the bad luck to make its acquisition bid right BEFORE Treasury's announcement. Ain't nothing fair about that.

It would probably be best for Congress to tackle this one head on, even as it deals with allegations that the direct bailout costs (the much-ballyhooed $700 billion) are being doled out indiscriminately. Let's hope they do!

The Newest Version of the California Budget Debacle

With the election out of the way, California Governor Arnold Schwarzenegger is displaying some optimism that Republican legislators will reconsider their opposition to any and all tax increases. So far, Republicans have been content with slashing services, borrowing heavily, and employing clever accounting games to get the current year's budget into balance. With more shortfalls staring the state in the face, however, the Governor has called a special session in which he has proposed a variety of tax increases, as well as spending reductions.

The Governor's previous plan to temporarily increase the sales tax by 1-cent has evolved into a plan to hike the sales tax (still temporarily) by 1.5 cents.

In addition, the Governor proposes:
- closing loopholes in the sales tax that allow a variety of personal services to go untaxed,
- instituting an oil extraction tax (California is the only major oil-producing state that lacks such a tax),
- raising the tax on alcoholic beverages,
- and enacting some modest increases in vehicle registration fees.

His plan would also include sizeable cuts in school budgets and health care services for low-income Californians.

Of course, the sales tax, alcohol tax, and vehicle registration fee increases would all hit low-income Californians hardest just as the budget cuts would. The fact that more progressive options have not yet surfaced is a major disappointment. Nonetheless, it seems clear that the state will have to raise revenue in some way, and the fact that a Republican governor traditionally opposed to tax increases has recognized that is a major step forward.

Unfortunately, though, that step forward has been accompanied by another step backwards, as the governor is simultaneously proposing to give millions in tax breaks to film and television companies.

And making matters even worse, California's budget hole could become deeper if the federal government does not act to reverse a little-noticed IRS ruling on the corporate income tax that we publicized last week.

Tax Commission Likely to Play Major Role in Future of California's Tax System

Alongside the budget struggles sure to dominate California headlines for the next few weeks is another tax story that could ultimately end up being even more important. The Governor, together with House Speaker Karen Bass recently agreed to form a "Commission on the 21st Century Economy" with the explicit goal to "stabilize state revenues and reduce volatility". While the Commission's recommendations won't be made until April 15, 2009, there has already been some speculation about what those recommendations will be. So far, expanding the sales tax base to include more services seems to be at the top of the list. Less encouraging, however, is talk of reducing the progressivity of the income tax.

As the fiscal contagion spreads among the states, policymakers are clearly casting about for ways to close large and growing budget deficits. In Nevada, Governor Jim Gibbons may be open to tax increases in light of a shortfall that is projected to reach $1.8 billion over the next two and half years, but he has also floated the idea of 'voluntary' payroll reductions of 5 percent. New Hampshire faces an approximately $600 million budget gap over the same period, with lawmakers weighing such options as selling state properties, legalizing gambling, or deferring needed payments to the state pension fund. Florida may have to confront an eye-popping deficit of $6 billion over just 18 months, driving elected officials to think about raiding a variety of trust funds and imposing a 4 percent across-the-board cut in agency budgets.

Of course, these three states have more in common than difficult days ahead. They also share a steadfast refusal to levy a personal income tax. Rather than continue to cast about for half-measures and temporary fixes -- or, worse, policies that would undermine working families' already precarious economic situations -- policymakers in states like Nevada, New Hampshire, Florida, Washington, and Tennessee need to acknowledge the elephant in the room and consider whether the tax policies that brought them to this point are the ones that will carry them to a better future.

Enacting an income tax would obviously be a step in the right direction for states like Nevada, New Hampshire, and Florida, but it would only be the first step. As ITEP's latest policy brief explains, states' income taxes must also be progressive, in order to balance out the regressive impact of the other types of taxes that states levy, like sales taxes and property taxes. States that do not have a progressive personal income tax will find it nearly impossible, over the long run, to fund public services in a way that is sustainable and fair.

At the very least, this means states' income taxes should provide meaningful exemptions to poor taxpayers and use a graduated rate structure to ensure that the very wealthy are paying their share. Unfortunately, though, as a new report from the Center on Budget and Policy Priorities documents, some states with personal income taxes are actually taxing the poor deeper into poverty. In fact, the Center's report finds that, in 18 of the 42 states that levy income taxes, two-parent families of four with incomes under the federal poverty level actually paid state income taxes in 2007. It also finds that 15 states make single parents with two children living below the poverty line pay state income taxes.

There are some straightforward solutions to this. For example, 23 states and the District of Columbia offer earned income tax credits (EITCs) which reduce income taxes for poor families and sometimes provide a refundable credit that further offsets the regressive impact of other state taxes. Plenty of states with personal income taxes could also make their rate structures more progressive, which would ensure that high-income families pay a bit more, as a share of their income, than low- and middle-income families.

Also troubling is that some states that do the right thing and use fairly progressive income taxes -- such as Rhode Island and California -- are considering fundamental changes to those taxes. As ITEP's Jeff McLynch observes in yesterday's Providence Journal, policymakers in Rhode Island should be strengthening the progressive character of their state's income tax, rather than seeking to diminish it.

Last week New Jersey residents got word that current fiscal year tax collections are down and the state budget shortfall may reach $1.2 billion. The future doesn't look much brighter, as the shortfall for fiscal year 2010 is expected to more than quadruple to an astonishing $5 billion.

Late last month, we discussed Governor Jon Corzine's rather unimpressive stimulus package. It includes proposals like the introduction of the "single sales factor" and eliminating the state's "throw out rule." Together, these proposals could allow many large New Jersey companies that do business across several states to avoid tax liability.

To be fair, other components of Corzine's stimulus package, like giving more money to food banks and increasing aid to residents in need of heating assistance, would help those hardest hit by these tough economic times. But the Governor did little to distinguish between helping people and boosting corporate profits when he said, during a recent briefing, "Everything that we talked about in the stimulus program I think is more important today than it was before."

For some more commonsense, responsible policy alternatives, read Mary Forsberg's report from New Jersey Policy Perspective, What's the Rush? Costly Tax Changes Need More Deliberation. We second Mary's suggestions about the need to carefully consider a variety of reform options including combined reporting, corporate disclosure, and publishing a tax expenditure report. We urge the Governor and others to follow Mary's advice before quickly and perhaps carelessly pushing through the aspects of the Governor's stimulus that amount to poorly targeted tax cuts.

Better late than never?
The truth of this saying may be tested in coming weeks, as lawmakers and regulators grapple with the question of how to fix an under-the-radar corporate tax break for a few large banks (the federal tax cut for Wells Fargo alone has been estimated at over $20 billion, and the new tax break overall could cost US taxpayers $140 billion) that seems to have been approved without Congress agreeing to it.

A Citizens for Tax Justice report from last week outlines the story:

When one company buys another company that has tax losses, the law prevents the acquiring company from using the purchased company's tax losses. There's a very sensible reason for this rule: to ensure that companies don't purchase other companies simply as a tax dodge.
But a little-noticed September IRS administrative ruling creates a specific, temporary exemption from this rule for banks acquiring other banks whose tax losses are attributable to bad loans.

It's not that often that a new tax cut gets implemented without Congress ever lifting a finger, but that's what happened when the Bush Administration's Treasury officials decided to reinterpret an existing law in a way that would cut taxes dramatically for a few well-off banks. Senator Charles Grassley, who's accustomed to being at the steering wheel (or at least in the car!) when the tax policy express hits the road, is very angry about it, although he's stopped short of saying that the Administration's move is illegal.

Yesterday's Washington Post has a detailed story discussing how this came about, and today's Los Angeles Times has this story noting that the state if California stands to lose a couple of billion dollars of its own corporate income tax revenue to boot.

This is obviously an important issue for Congress-- the bailout was unpopular enough before it became widely known that it was being hijacked to benefit a few big corporations, so Congressional tax writers have a real incentive to clean this mess up in a way that makes it clear the bailout ultimately benefits America's economy, not a few fat cats.

But, as Citizens for Tax Justice notes in its analysis of the problem, this is also something state lawmakers need to worry about:

Because states with corporate income taxes almost universally base their corporate taxes on federal rules, federal tax cuts for corporations generally result in state tax cuts as well. When affected states have rules making it difficult to enact tax increases (as istrue of California, whose budget deficit is already in the billions of dollars), state governments find themselves practically unable to avoid costly corporate tax cuts they never wanted... At least eighteen states that tax corporate profits will likely take a hitfrom the new IRS ruling--and any state that taxes the profits of financial companies is at riskof helping to fund the next bank that chooses to purchase another financial company.

With state budgets already going up in flames, this is a problem state lawmakers don't need. Stay tuned...

Charges that Progressive Taxes Are "Socialism" Fail to Rally Support for Candidate McCain

Senator Barack Obama, who ran for president partly on a platform of ending George W. Bush's policies of cutting taxes for the wealthiest Americans, will be our new president starting January 20, 2009. He will have the support of a House of Representatives and Senate led by opponents of the Bush tax cuts.

His opponent, Senator John McCain, tried several times to frame the tax debate in a way that would lead average Americans to support tax cuts for the very wealthiest taxpayers. None of these attempts succeeded. At one point, the McCain campaign tried to get the public to pay more attention to Obama's vote for a non-binding budget resolution than Obama's actual tax plan. Later, a McCain surrogate argued that allowing the expiration of tax cuts for the richest 1.4 million taxpayers would be a tax increase on 23 million business owners. Near the end, McCain made an argument implying that the EITC, and really any progressive income tax, was socialism. Americans were not impressed with these arguments.

The 2008 election has important lessons for lawmakers regarding taxes. Arguments that taxes must be lowered for even the richest Americans simply do not work. Americans don't buy it. Nor do Americans buy it when proponents of tax cuts attempt to blur the details about who would benefit the most. There has always been polling that shows Americans do not support any and all tax cuts, but it took an election to make this real for many lawmakers.

The Path Ahead

Some people may speculate about whether the new President will muster the support needed to enact the proposals dear to them. We also feel this uncertainty, but it is mitigated by the crucial fact that the Bush tax cuts expire at the end of 2010. To put it a different way, if Congress simply does nothing, we will return to the tax policies in effect during the Clinton years, when the economy performed better than it does now, and when Americans were generally more positive about the direction of the country. That would be fine with us.

We know that Congress is not likely to do nothing. Congress, with President Obama's leadership, may enact tax cuts, including extending the Bush tax cuts for those who are not rich. (Since such a gigantic share of the Bush tax cuts currently goes to the rich, Obama's proposal will lose much less revenue than would candidate McCain's proposal to extend them for even the richest families.) And Congress is likely to act on at least some of President Obama's proposals to enact brand new tax cuts for low- and middle-income Americans.

But those lawmakers who insist on extending the Bush tax cuts for the even the richest Americans have no cards left to play. Their cherished handouts for the rich expire in a couple years and the new president is not likely to sign any bill that extends this party for the most privileged.

Of course, a great many details must be worked out. Obama wants to repeal the Bush tax cuts before they expire for the very richest families, and some lawmakers will dig in their heels to oppose this. Another question is the extent to which new tax cuts will be paid for. While most analysts agree that balancing the budget is not a priority during a severe economic downturn, we certainly hope that Congress will not enact huge, permanent tax cuts without replacing most of the revenue -- revenue needed to fund health care initiatives and other investments that have been short-changed during the Bush administration. There are ways that Congress can raise revenue that go beyond what is included in Obama's tax plan, and we will be making these suggestions to the new administration. And of course there are some tax cuts that Obama supports that would benefit the wealthy -- like a partial extension of the Bush tax cuts for dividends and estates -- and we're going to have an interesting conversation about that.

But the most salient fact is that the surreal era of leaders telling us that taxes must be cut most dramatically for the wealthy is over. This is a sea change. We may have trouble explaining to future generations how such a bizarre ideology ever took hold. But we will have no trouble explaining that on Tuesday Americans looked at the long list of problems facing this country and decided that cutting taxes for the rich should not be considered a priority.

For eight years we have had a White House fixated on tax cuts for the rich, at the expense of all other priorities. Now, the millions of Americans who lack health insurance or who are underinsured, the newly unemployed, the families losing their homes, and Americans serving their nation in the armed forces all know that their struggles are finally back at the top of the agenda in Washington.

Massachusetts, North Dakota, and Oregon residents rejected regressive and costly income tax cuts (or even outright repeals, in the case of Massachusetts) in each of their respective states this Tuesday. The results in every state were fairly lopsided, with between 60% and 70% of voters coming out in opposition. As we noted in earlier Digest articles, these victories for fair tax policy are partly the result of hard work by progressives and also partly the result of very broad (and sometimes unexpected) coalitions. This cooperation symbolized a growing recognition of the importance of taxes in paying for valued government services and generally improving Americans' quality of life.

The votes in these three states are especially important given the economic slowdown that is laying waste to state budgets across the country. Massachusetts is already projecting a mid-year budget deficit, while Oregon is projecting a deficit in the next fiscal year. North Dakota, though doing well relative to other states, is unlikely to escape the slowdown without similar budgetary wounds. Given such a difficult environment for state budget-makers, it's not at all hard to see that tax cuts are the exact opposite of what is needed -- especially if those cuts are targeted overwhelmingly to the rich.

Multiple stories and descriptions of each of these failed measures can be found in the Tax Justice Digest's Massachusetts, Oregon, and North Dakota archives.

Colorado's ballot outcomes represent the most serious defeat of good tax policy to take place in this election. A proposal to send the automatic TABOR refunds into a savings account for education, as well as another proposal to end a costly and unnecessary tax break for the oil industry both fell short. Each of these proposals had the potential to secure more revenues for the state at a time when Colorado services are suffering, and the state is facing a mid-year budget shortfall. Descriptions of both of these failed proposals can be found in our Colorado archives.

Arizona voters wisely rejected Proposition 105, a proposal that would have placed a nearly insurmountable obstacle in the way of Arizona residents seeking to raise their own taxes through the referendum process.

Arkansas voters approved a measure to institute a state lottery. While the state could certainly use the additional revenue, Arkansans should be wary of funding their government through regressive revenue sources such as the lottery.

Maine residents rejected an increase in the alcohol and soda taxes to fund health care. While it's certainly a bad thing that these taxes are regressive (as well as unlikely to exhibit sustainable growth in the coming years), the ludicrousness of the fervent opposition this relatively minor tax created can be read about in this Digest article and this blog post.

Maryland residents also decided to secure additional revenues for their government via expanded gambling, in the form of 15,000 new slot machines. Check out this Digest article to learn about some of the problems with this proposal.

Missouri also attempted to increase its haul from gambling. Increased gambling taxes and the elimination of limitations on the amount of money one is allowed to lose were approved by voters this Tuesday. This Digest article explains how the proposal leaves much to be desired.

Minnesota voters decided to go through with a 3/8ths percent sales tax hike. While the environmental causes to which the funds will be dedicated are undoubtedly worthy, the regressive way in which voters decided to go about funding the projects (through the sales tax) is far from ideal.

Nevada residents voted to amend their constitution to require that all new sales and property tax exemptions be subjected to a benefit-cost analysis, and accompanied by a sunset provision that will force their reexamination in the future. While the proposal sounds good in theory, its requirements are relatively loose in practice. It will be up to Nevadans to carefully watch their representatives to ensure that the spirit of this law is adhered to. Learn more about this proposal here.

In late September, while the major presidential candidates debated solutions for reforming the federal corporate income tax, a little-noticed ruling by the Internal Revenue Service (IRS) opened the door for widespread corporate tax avoidance by a few of the biggest, most profitable financial institutions in the country. The IRS ruling, which took Congressional tax writers by surprise, will almost certainly push the federal government -- and many states -- further into the red at a time when they can least afford it.

Read the CTJ press release